One famous free meal in history was the twice-daily manna for the
community. Another famous free meal was the loaves and fishes for the
multitudes. The Three-Factor Model for stock pricing is alleged to be in
effect a perpetual free lunch for
investors worldwide.
Instead of
bread- and flesh-flavored manna or loaves and fishes, the two miraculous
ingredients of the model are the size and value factors. Size (market capitalization) and
value
(book-to-market equity ratio) inspired the founding of many stock mutual
funds.

In simple form, the Three-Factor Model is R = M + S + V. In words,
expected return is determined by market, size and value. Based on
empirical samples, it alleges that to
increase return, one should buy small-cap high-value (value-style) stocks
and sell large-cap low-value (growth-style) stocks.

Yet this increasingly adopted modern-day miracle is a fatal fallacy.
The model
commits the fallacy of circular reasoning, a/k/a begging the question, in
which a premise is taken to be the same as the conclusion to a logical
argument. Technically speaking, it is a logically circular type of
single-equation simultaneity, which occurs when the same identical
variable, such as price or shares, appears on both sides of the model
equation. The size and value fallacies are concealed. They are
fatal because they are irremediable. They are terminal because they end an
argument and cause a model to be rejected.

The
Three-Factor Model is a hoax created by prominent academicians who have reason to know it is not scientific. The fatally
fallacious size and value stock-pricing factors are a contagion spreading to bourses worldwide. Because of the
fatal fallacy, the Three-Factor Model is meaningless, non-interpretable,
indeterminate and pseudo-scientific.

If you believe the Three-Factor Model earns consistent long-term average
risk-adjusted
expected returns higher than general stock market indexes, then you will believe the analogous Two-Factor Model does
so. In math, R = C + D. In words, expected return is determined by
capital gains and dividends. This is a definition of total return, and
definitions are a form of circular reasoning.

If you believe in the Three-Factor Model and in the Two-Factor Model, then
you will believe in the analogous One-Factor Model. In
math, R = R. In words, expected return is determined by return. This is an
identity and a tautology, which are forms of circular reasoning.

If you believe in these three logically equivalent models, then you
implicitly believe in a perpetual free lunch. The investors who so
believe pay excessive asset management fees on size-related and value-related
index mutual funds for the false promise of higher expected returns. The typical retirement-savings plan investor loses $20,000
due to these excess fees. Excess fees are estimated to exceed
one billion U.S. dollars total in a year.

If you so believe, maybe it is time to refresh your
skills in critical thinking and to review your stock investments to
identify implicit free lunches.